The Negative Mean Output Gap

Download or read book The Negative Mean Output Gap written by Mr.Shekhar Aiyar and published by International Monetary Fund. This book was released on 2019-08-23 with total page 24 pages. Available in PDF, EPUB and Kindle. Book excerpt: We argue that in an economy with downward nominal wage rigidity, the output gap is negative on average. Because it is more difficult to cut wages than to increase them, firms reduce employment more during downturns than they increase employment during expansions. This is demonstrated in a simple New Keynesian model with asymmetric wage adjustment costs. Using the model's output gap as a benchmark, we further show that common output gap estimation methods exhibit a systematic bias because they assume a zero mean. The bias is especially large in deep recessions when potential output tends to be most severely underestimated.